Finance Minister Nirmala Sitharaman's recent announcement of a significant increase in the Securities Transaction Tax (STT) during the Budget presentation for the upcoming fiscal year has sparked debate in financial circles. According to Nithin Kamath, founder and chief executive of Zerodha, this move could prove counterproductive if the government's intention is to curb speculative activity in the futures and options (F&O) market.
STT Hike Details and Market Reaction
With the stated objective of discouraging small investors from speculative trading in derivatives, Sitharaman announced a steep hike in STT rates. The government expects to collect approximately ₹73,700 crore through STT in FY27, compared to an estimated ₹63,670 crore in the current fiscal year, which is lower than the previous projection of ₹78,000 crore.
In her Budget speech, the Finance Minister specified that STT on futures contracts would be raised to 0.05% from 0.02%. Meanwhile, STT on options premiums and exercise of options are proposed to be increased to 0.15% from 0.1% and 0.125%, respectively. This announcement triggered an immediate negative reaction in equity markets, with both Sensex and Nifty 50 indices losing over 2.5% in intraday trading following the Budget presentation.
Kamath's Analysis of the STT Impact
In a detailed social media post on platform X on February 2, Kamath expressed skepticism about the effectiveness of the STT increase in reducing speculative activity. "I don't know the exact reasoning behind the increase in STT. Having said that, if the goal was to reduce speculative activity in F&O, then I'm not sure this will do anything," he stated.
Kamath highlighted a crucial structural aspect of how STT is applied across different derivatives products. He noted that STT is levied on the full contract value of futures, while options continue to be taxed largely on the premium component. This fundamental difference means that any increase in STT makes futures progressively less viable compared with options from a transaction cost perspective.
Options Dominance in F&O Trading
The Zerodha founder pointed out that nearly 95% of derivatives trading volumes in India are already concentrated in options. Kamath believes the latest STT increase would likely push this share even higher, as the tax hike disproportionately affects futures contracts. "Options are inherently more speculative than futures, but the impact of the STT hike mostly falls on futures," he explained.
This analysis comes against the backdrop of a Securities and Exchange Board of India (SEBI) study showing that approximately 92% of retail investors lose money in derivatives trading. While the government aims to protect these investors from speculative losses, Kamath questions whether the STT approach will achieve this objective.
Uncertainty from Repeated Tax Hikes
Kamath raised additional concerns about the uncertainty created by frequent and incremental increases in STT rates. "The other problem with the uncertainty from steady STT hikes is that, at some point, you'll start seeing a material impact on trading volumes because transaction costs make trading unviable. You're already kinda seeing that with futures," he warned.
This uncertainty affects both brokers and traders, potentially leading to reduced market participation and liquidity over time as transaction costs accumulate and make certain trading strategies economically unfeasible.
Alternative Approaches to Curb Speculation
If the primary objective is to rein in speculation, Kamath suggested that alternative regulatory approaches might prove more effective than repeatedly raising transaction taxes. He specifically mentioned the potential benefits of introducing product suitability norms that would define which investors can trade complex derivatives products.
"I know it's an unpopular opinion," Kamath acknowledged, "but it's a much better approach than a death by a thousand STT hikes."
Policy Recommendations for Market Development
In previous commentary, Kamath had advocated for a different policy direction focused on boosting activity in cash equities and futures markets rather than attempting to suppress options trading. He argued that reducing STT for cash and futures while increasing intraday leverage could naturally shift trading volumes toward these segments.
"If STT were brought down for cash and futures, and intraday leverage was increased, I think the trading volumes in cash and futures would automatically go up. It is a much better strategy to increase cash/futures volumes than to reduce trading volumes in options," Kamath had stated in earlier remarks.
The debate around the STT increase highlights the complex balancing act regulators face in attempting to protect retail investors while maintaining vibrant, liquid markets. As the financial community continues to analyze the potential impacts of these tax changes, market participants will be closely watching how trading patterns evolve in response to the new transaction cost structure.
